Mario Monti’s government today approved an ambitious plan that may be the last bullet to save Italy from default and preserve the EZ as we know it. The challenge is to combine an ambitious fiscal consolidation plan, roughly 2% of GDP, with the need to foster growth, while sharing the burden of the adjustment as fairly as possibly. Most observers agree that to this aim he should a) reduce the cost of politics; b) let the rich contribute their share and curb tax evasion; c) reform the pension system; d) shift taxation from labor and capital to consumption and property, e) privatize and liberalize services. In short, do in the eighteenth day in office what Berlusconi has not done since 1994. Can the Monti plan achieve all this? The market seems to thinks so, as the BTP-Bund spread collapsed from 473 yesterday to 375 bp today.  They may be right.

The plan is quite comprehensive: a) there is a cut to local governments, and a rationalization of the multiple social security institutions. More could have been done to reduce the “cost of politics”, for example by cutting MP’s generous salaries, benefits and pensions, but the government would have taken risks in Parliament. b) Tax authorities are  now granted full access to taxpayers bank accounts, so tax evaders will finally face hard times;  c) universal pension reform moving the system from a pay-as-you go to a contributive system, ending an ever-lasting succession of half- baked reforms that produced a web of privileges and inter generational inequalities d) businesses’ tax burden is reduced as new deductions are granted for labor costs and investments, while SME benefit from an expanded credit guarantee fund; most extra revenues will come from the (re)introduction of a tax on real estate, but the home of residence, owned by more than two thirds of Italian households, will be taxed less.  A levy on financial wealth, might have been preferable on equity grounds, but would have hastened the flight from the domestic stock and bond markets. d) The shift in the revenue composition and the main source of budget consolidation, together with the property tax, is VAT. The VAT rates are raised two 2 points (from 21 and 10 percent) and there are new taxes on luxury goods and illegally exported capital, previously favored by tax amnesties, are now taxed. Privatization of state properties is envisaged, and a few liberalizations (pharmacies, opening hours for shops, gas stations), implemented.

Will Monti be able to achieve a balanced budget in 2013 without plunging the economy into recession? This is clearly the big bet. The government has announced an ambitious plan for labor market reform which is yet to be disclosed. Yet unlike Berlusconi’s previous attempted adjustments,  where  2/3 of the consolidation was made by higher taxes and only 1/3 by  lower expenditures, here, according to the government, we have progress: higher  taxes account for “only” 56.6% (17 billion), while 43.4% of fiscal savings come from spending cuts (13 billion).